Acceptable Churn Rate

In line with my experience and as I cited in my Sandhill.com article, Bessemer Venture Partners says an acceptable churn rate is in the 5 – 7% range ANNUALLY, depending upon whether you measure customers or revenue.

The way I read the results of Pacific Crest’s survey is that 30% of SaaS providers surveyed have an unacceptable level of churn.

Now what about the SaaS providers that aren’t included in surveys like that one or who don’t appear in the logo list of the top investor portfolios and who are just trying to grow? Are they doing better or worse?

In my experience, it’s quite often worse… and sometimes much worse (as you’ll see in a second).

Honestly, for those companies, it isn’t a lack of customers in the front door that is stopping their growth; it’s the constant flow of customers out the back door that is killing their business!

Monthly vs. Annual Churn Rates

Now, just so we’re on the same page, 5% – 7% Annual churn – the good churn rate – translates to 0.42 – 0.58% monthly churn.

This means companies with acceptable churn only lose about 1 out of every 200 customers (or dollars) per month.

Now that’s a solid platform you can really build a high-growth company on.

On the flip side, a high churn rate is the reason you ended 2012 with a whole bunch of new customers… but had about the same amount of revenue.

Churn is the reason that – though you acquired a lot of new logos in 2012 – you had no significant year over year growth from 2011.

Is 5% Monthly Churn Good?

To really hit this point home, here’s a story from a conversation I had last week.

His goal is to double his business over the next 12 months… to 2x their current revenue.

To help reach that goal, he contacted me because he knew I could help with the things he thought were key to reaching his goal.

He knew that I could help increase customer acquisition by improving the quality of traffic to their site, improving the number of prospects entering his free trial and, of course, improving the conversion rate to paying customers of those that enter the free trial.

But as part of trying to get to the bottom of things, I asked him what his churn rate was.

Since he didn’t contact me to talk about churn he wasn’t really interested in discussing this (this, by the way, is always a bad sign; as the CEO of a SaaS company you should be open to discussing ALL ASPECTS of your business when you’re looking to grow).

He reluctantly told me he had a 5% churn rate but that it is “just fine.”

I asked him if that was 5% per year or per month… one is great the other not so much.

He confirmed it was 5% per month but reiterated that “it is fine.”

No, 5% Monthly Churn is Bad!

Now, just so you and I are on the same page… 5% monthly churn IS NOT FINE!

It means that if you didn’t add any new customers (which is unlikely) or measured on a cohort basis (this is a very accurate way), you’d see that 5% per month leads to ~46% churn. Read on.

Put this in a spreadsheet cell and hit enter: =(1-.05) ^ 12

The output is something like: 0.540360087662637 (see my over-simplification disclaimer at the end)

Make it 54, subtract that – which is the retention rate – from 100 and you have the annual SaaS churn rate: 46.

Turn that into a percentage, and the annual churn rate is: 46%

A 5% monthly churn results in… a 46% annual churn rate!

Let me add some color…

Having 5% monthly churn means if you started January with 100 customers you’d have 54 customers left at the end of December.

If you started with $100 in Monthly Recurring Revenue (MRR) you’d end up with $54/MRR at the end of December.

Think about it this way… over the course of the year where you start with 100 customers or $100/MRR but have 5% monthly churn, you’d need to acquire 46 customers (or $46/MRR) just to break even with the beginning of the year.

To grow by just 1 customer you’d have to acquire 47 customers!

To grow by just $1, you’d have to acquire $47 in new business!

If you start the year off with 100 customers, and you add 100 customers per month (and depending upon where the 5% churn from; cohort or total), you’ll end up with 25-29% annual churn.

If you add 1200 customers over a 12 month period and end up with a little more than 900 over that same period, that is probably not good.

Of course there are several factors to consider here, but in B2B SaaS where we’re looking for customer lifetimes of at least 36 months (and likely spending more than in B2C to acquire customers), this is clearly working against our goals.

Okay, so…

Why Do SaaS CEOs Ignore Churn?

Why this was not shocking to him I’ll never understand, though I can assume it was for at least one of these two reasons…

His company continues to acquire customers at a rate that is fast enough to break even or show some slight growth (which is why they think they just need to ramp this up)

He assumes a high churn rate is the norm; it’s expected and just fine.

What this really means is that with 5% MONTHLY churn, the CEO who said “it’s fine” is running a company with a 46% annual churn rate!

It means his company, the one that is “just fine,” is losing 50% of their customers or revenue every year.

At first I was happy to hear he has no Board of Directors to report to (so we could just get to work), but after hearing him say 5% monthly churn is “fine” I wish he did have someone to hold him accountable!

Now, while it’s not impossible to double your business in a year with such a high churn rate (this isn’t unheard of in the B2C world), it is hard.

And in our world “hard” means expensive and time-consuming.

It means running backwards on a treadmill blindfolded while lighting $100 bills on fire… eventually you might reach your goal weight, but you look like an idiot and waste a lot of money in the process.

The reality for this SaaS CEO I was talking to – and anyone else with a high churn rate – is that this is not a solid foundation to build a business on.

Rather than a solid foundation, you have a super-porous, extremely brittle wafer – like a piece of shredded wheat – that you’re going to try to build a business off of.

Or a dry sea sponge. Or a structure made from dry angel hair pasta. You get the picture.

Negative Churn and Expansion Revenue

Yes, you might have “negative churn” or “expansion revenue” where you lose some customers but the ones that stay pay you more over the course of the year.

That’s awesome! Expansion revenue is the best.

Unfortunately, in my experience, SaaS providers with high churn rates often don’t know how to effectively up-sell, cross-sell, or even down-sell so their churn rate is rarely offset by expansion revenue.

And the cost of acquiring more customers – especially when accurately figuring in all sales, marketing, on-boarding, and support costs – will frequently do more to offset what expansion revenue they have than the other way around.

As well, their pricing models are usually such that they don’t effectively move customers to higher pricing tiers and, in fact, often have non-value differentiators (like storage) separating pricing tiers so that customers game the system to avoid paying more (a major churn threat, by the way).

That said, assuming you’ve got up-sells and cross-sells that work and you have a pricing model that encourages customers to use more so they pay more to drive expansion revenue, how much better would it be if you could expand revenue over a larger customer-base by keeping more customers?

Right… so even when arguing for expansion revenue, I’m also arguing for lower churn.

Not all SaaS are created equal

Of course – like everything else in SaaS – lots of other market, category, and company-specific inputs come together to drive the churn that is outside of your control.

For instance, in the email marketing category – where I’ve worked with seven providers over the last year – there seems to be a much higher propensity for churn, especially at the lower end of the category.

However, the companies I’ve worked with – even in a market where the expectation is high customer turnover – we’ve been able to reduce the churn rate and extend customer lifetimes significantly.

How to Reduce Churn

First, though, you have to get them to start using your service – either through a sale or in a free trial – but without over-promising and by otherwise managing expectations properly. I’ve actually seen a large amount of customer churn directly correlated to missteps during the sales and on-boarding phases, by the way, so keep that in mind.

Then, once the customer is up and running your only job is to ensure they keep realizing (more and more) value from your service.

While you may not add years to your customer lifetime or eliminate churn entirely, what could you do with an extra 6 months of revenue from your customers on average? What would that do to your company valuation?

A Complete Over-Simplification of Churn

Let me be clear… I’ve way over-simplified how to calculate churn for this post because I want you to start thinking about how churn can affect you and not get caught up in the details or turned off by crazy math.

The reality is that while churn is often seen as a linear function, customer retention is generally charted as a curve with actual losses – both customer and revenue – progressively decelerating.

But rather than going into how to waterfall out monthly revenue from the declining customer base, using cohort analysis, determining estimated customer lifetime, measuring revenue vs. customer (logo) churn, etc., I just wanted to present the simplest of real life examples to get you thinking.

What would you do today if you realized you had a churn rate that was too high? If you don’t know, that’s what I’m here for.

Let’s Fix Your Churn Problem!

For immediate consultation and advice on fixing your churn problem, schedule at least a 15-minute meeting with me via Clarity. If you feel a more involved engagement is required for me to help you, email me with the specifics of your situation (as much detail as you’re comfortable giving) and we’ll setup a meeting to work through the particulars.

I am a Customer Success-driven Growth Consultant. I wrote the Customer Success book which you can buy at Amazon. If you need help growing your SaaS, request at least a 15-minute call with me via Clarity. Be sure to join my mailing list - I send awesome stuff to the list every week or so. Also, connect with me on LinkedIn or follow me on Twitter.

Comments

Maybe or maybe not. What if my product packaging, sales, and advertising is tuned such that I catch a lot of strays. In the process. Keeping them would be great, but in order to ensure my net is wide enough would I not feel like I was doing a good job if I caught a few porpoises as “collateral damage”

In other words, what if I had a $2.99/mo. emoji creator saas site with 25% churn is this bad or should I say, “wow, 75% are hanging around for another month!”

Of course.. but first and foremost my audience for this article consists of B2B companies who expect to have a 36-month (or longer) customer lifetime but don’t.

My goal was to get those people thinking about churn and how a high churn rate might not be the reality they have to live with. I want to give them a reason to think about reducing churn and not just deciding to live with it or try to grow around it.

Regardless of the market (which absolutely affects churn rate), what if instead of saying “wow, 75% are hanging around for another month” you could say 80%… what would that do to overall revenue?

That all said, there will always be exceptions to every rule – especially in B2C and mobile – and all you can do is try to get as much engagement as possible and – as we see especially in mobile – you need to be good at cross-selling the next product for the fickle market.

If you’re in non-mainstream or niche or not in a horizontal product category and therefore have a limited addressable market in the first place and you have a super-high churn rate and no cross-sells to other products… that’s a recipe for disaster.

No problem Lincoln – just trying to get my Lincoln fix in lieu of meeting up in person. 😉

I’ve done the SaaS thing for b2c and b2b and it is a challenge. I’m now back in it with Colligent and one of the things I am doing is packaging the service it for monthly subscriptions at tiers up to $6k/mo. It’s a small market targeting large brands and brand agencies. FWIW, I’ve forecasted a 15% churn for year 1. As we get a sizable customer base of 100 or even 50 customers I see myself getting very frustrated with a churn rate this high though.

All I can offer to early-stage startups is advice to “get it as right as possible” out of the gate. You can make up whatever churn rate you want at first – 15% sounds plausible – but being in-market has a way of quickly exposing business plans and forecasts for the fortune-telling gimmicks they are!

That said, if you do the well-known things to keep churn low that tend to work across the board, your high churn rate in year one won’t be a false positive… it’ll be indicative of something that’s actually wrong. But if you fail to do the basic things required for long-term customer retention, you could come to the conclusion that your service isn’t working and make decisions that aren’t based in the right facts.

Of course, great churn reduction and customer retention techniques rarely work for long if your product sucks or doesn’t serve an actual purpose.

Year one is for learning… and I’m excited to see what you learn with Colligent for sure!

I don’t understand your calculation of monthly churn rate. The way you calculate it, it looks like the rate of attrition relative to the entire year. But that’s not a very useful number. And then I don’t understand how that translates a loss of 1/200. One could reasonably assume the attrition-rate is constant throughout the year, therefore if it’s 5% pa, it’s also 5% pm and not as you suggest (5/12)% = 0.42% . Would you mind explaining.

You’re 100% correct… none of these metrics actually give you a good view of what’s really going on. You need to define your view of churn in a way that is meaningful – and actionable – for your situation.

I would suggest looking at both revenue churn and customer churn and – in a real life situation – doing so on a cohort basis.

But this article was just to give a high-level overview, with simplified math, to introduce the reader to the concepts. The key takeaway shouldn’t be the math… but that high churn is a significant drag on growth.

Reducing churn is always a worthy goal, though in my experience few SaaS companies get their churn down to 5% to 7% annually – high single digits is generally pretty good for a “sticky application”. I find benchmarks for retention varies significantly by vertical market, size of company, size of the deal, and by the type of application. It is easier to switch CRM providers than ERP, big company deals have longer sales cycles, but lower churn.

From an economic perspective, “acceptable” churn is a function of the number of months of profit to recoup the sales expense. If the cost of sale equals 2 months of Monthly Gross Customer Profit (not MRR) and higher churn is tolerable versus a sale that requires 12 months to recoup the sales cost.

Whatever the churn is, churn reduction is the least expensive way to maximize revenue.

While I agree with most of what you said, I’m a bit confused by your definition of “acceptable” churn being a level that allows for CAC payback (regardless of the timeframe). If it takes 2 months to pay back, but they churn out after 2 months… what was the reason for even having them as a customer? Why be in business if that’s the “acceptable” level of churn? At the very least you should get one profitable month with that customer, right?

The companies I work with aren’t in business to break even on acquisition costs… they’re in business to generate profit, which means once CAC is paid back the real work begins of maximizing the lifetime of the customer.

Sorry for the confusion. I didn’t mean to imply my example of a 2 month retention time is acceptable (though I’ve seen a now dead ringtone company that had a business model that assumed they would lose 50% of the customers after 2 months).

My point is from an economic standpoint, if the months of gross profit required to cover the cost of sales is half in one business than another, the churn “could” be twice as high with the same. The math is looking at the ratio of Sales Costs to Life Time customer Value. The huge caveat is that assumes you can get as many customer as desired just by cranking up the sales “investments” and also ignores the damage to the company’s reputation caused by customer being so disinterested or disappointed in the company that they have a high churn rate.

I’ve worked with a company selling to small retailers where they had well over 5% of the customers go out of business or were acquired each year — those were customers that no retention program could save. This unavoidable churn together with their “normal” churn was so high that it capped their amount of sales expense to bring in another dollar of MRR could be to be a viable business.

Gotcha… you’re right. In fact, I said in the post “Of course – like everything else in SaaS – lots of other market, category, and company-specific inputs come together to drive the churn that is outside of your control.”

The main reason I write posts like this is to get people to think differently about things they think they know.

So even where you have those things that are historically or popularly considered to be outside of your control – like a high churn rate in this market/industry/whatever – I challenge my readers and clients not to accept that but to strive for something better.

If anything, it’s a great thought experiment and might just yield positive results…

Do you have any information if the way how Pacific Crest calculates the churn is commonly used? Could one think of that as “the recommended/standard way to calculate churn”?

Here’s their definition: “Gross churn is the percentage of ACV from existing customers that is expected to be lost on a one year period due to non-renewals, not taking into account the benefit of upsells or increased usage”

Do we look at revenue or customers? VCs investing in Enterprise SaaS tend to want 95% per year customer retention with 110% revenue retention (expansion)…

Okay, but does this apply to line of business, departmental, or SMB SaaS? No. What about B2C? Definitely not.

Ok, then you get into whether churn is calculated annually, monthly, or only on a cohort basis. It depends… they’re all useful, but they have different uses.

The best thing you can do is explain to people why churn is bad and give some different ways to measure it.

Then there’s the question of whether churn is even a meaningful metric in the early stages of a company. And if it’s not, when does it become meaningful? I’d say Product/Market Fit as the cutoff, but that assumes we all agree on Sean Ellis’ definition of P/MF.

I’ve found many companies that are clearly past the “it’s meaningful” stage don’t even measure churn or if they do they don’t look at the right way, which is why I focus less on how to measure it and more on why it matters (i.e. it can kill your growth and have a seriously negative impact on valuation).

The most import thing is to figure out how you’re going to measure it and stick with that (and make sure others looking at your figures – investors, board members, advisors, etc. – are looking at your figures the same way) so you continue to make and apples to apples comparison.

Then, when you inevitably change the way you measure churn – or any of your KPIs – you’ll need to go back and recalc everything so you’re still making apples to apples comparisons.

You do an excellent job of making your case. I am always amazed at how easy it is for people to overlook the obvious because they find it unpleasant. Your article cuts right to the heart of the matter in a clear, concise way. Our B2B SaaS has an annual churn rate of about 1%, so I can attest that customer retention is indeed possible. We look at our customer service efforts as equally important to our growth as our sales team. To me, high churn is like trying to fill a bucket with a hole in it. You can fill it, but it takes far too much effort and it won’t stay full for long.

I think of acceptable churn in a startup context in terms of focusing where you can have the most impact. Starting out, you probably need traffic and hustle more than retention efforts. Then you’ll likely need to improve conversion, tuning your features and your message. Eventually, you have to focus on churn to grow the business.

Lincoln, Can you share more details for those of us in the SMB world? As 25% of SMBs go out of business in their first year, and that stat grows to almost 50% in many SMB categories in their 4th year, it’s hard to imagine that any SaaS serving this market can be in the 5-7% annual churn range.

Remember how in the post I said in the post “Of course – like everything else in SaaS – lots of other market, category, and company-specific inputs come together to drive the churn that is outside of your control.”

That applies here.

While I’d say that SMB stats like 25% fail in the first year and 50% die within 4 years sound true, I’m less sure they apply across the board. Restaurants, for example, likely bring down the average as 80% tend to fail in the first 3 weeks (I made that up, but you get the idea).

So I’d rather know what the failure rate is for the type of businesses that make up your Ideal Customer.

Perhaps local, independent stores also have a high failure rate (they probably do), so you need to take that into consideration.

But if they’re successfully using your product, maybe the failure rate will be a little less, right?

So the main thing is to understand that whatever churn IS in your control should be as low as possible and I can’t really think of reasons – outside of actively driving bad customers away – why that is a topic for debate. But I’m open to it for sure.

The main reason I write posts like this is to get people to think differently about things they think they know.

So even where you have those things that are historically or popularly considered to be outside of your control – like a high churn rate in this market/industry/whatever – I challenge my readers and clients not to accept that but to strive for something better.

If anything, it’s a great thought experiment and might just yield positive results…

One thing I think SaaS businesses fail to think about RE: churn rates is how important it is that the rate itself is actually calculated correctly. As you said yourself, metric definitions vary based on industry, market, etc, but in generally, if the SaaS business is in high growth, then depending on if the business measures average customers over the period, the addition of new customers could artificially lower churn, making it look better than it actually is.

In a previous life at another SaaS company, a decent churn rate was seen as a great success but was partially due to a doubling of the customer base every ~9 months or so. By measuring the churn rate off cohort, the measure became ~4% higher (annualized, from 8% to 11%, rounded) than the other measurement.

This can (and did) lead to incorrect decision-making at the executive/board level and should be a cautionary tale for all readers. As soon as that growth rate in new business stalls, all of a sudden it looks like you have a new churn problem when in fact that churn problem was there all along; you just didn’t see it.

Thanks for this! Very good points. One thing I would like to add (and would appreciate you commenting on) is the impact of customer tenure on churn.

We see much higher churn in our first year of subscription than in subsequent years: If they don’t cancel in year one, we keep them essentially forever. That big difference in Year 1 Churn vs Subsequent Year Churn is common among the SaaS businesses I speak with on a regular basis.

For SaaS businesses with this dynamic, they’ll have much higher overall churn during periods of really fast growth (when a greater percentage of their customers are new) than in periods of slower growth (where the great majority of their customers have been with them for some time).

For this reason, we track overall churn *and* cohort churn (by quarter of tenure). High churn in year one is often an adoption/product issue that we can address. Sometimes it’s a product of us selling into a less qualified market (perhaps a segment with a higher business failure rate, or less of a direct fit with our offering). High churn after year one is a bright red flag that may signal deeper, more foundational problems. Fortunately, we don’t see that in our business, but we absolutely track it.

Great point on doing cohort analysis. In fact, that’s the only way to get to any real, actionable data. Roll-up of all churn is good for reporting, but not so good at telling you what you actually need to work on.

Every company has a “customer longevity cliff” or CLC (I just made that up) where, once reached, a customer will essentially stay forever or, to the estimated Lifetime (eLT) of customers. For you, it’s after 1 year… for some, it’s after 3 months, but it’s always there.

Which means you need to work diligently to ensure your customers are achieving success before the CLC, so they’ll stay on. But I always challenge the companies I work with to reduce the CLC. If it’s 3 months, get it down to 2 months. That means, if they stay 2 months, they’ll hit the longevity cliff and stay for the eLT.

For you, the first annual renewal, okay… how could we ensure they hit the CLC at 9-months? Could we do a Business Review with them and get buy-in that they’ll definitely renew at that point? Not sure what’s possible in your situation, but that’s how I like to think about it.

Great post. I wanted to ask — are you aware of publicly traded companies that disclose these churn metrics annually? Or any such customer acquisition / total end of period customer-type information? It would be interesting to see the hard numbers from companies like these, but it seems to be hard to come by.

I have a question regarding defining churned user. Lets say for a free service?

Should I only consider users who have used the service for a while and then stopped and have not had any interaction lets say the next 14 days?Should I exclude users who just register an account to sniff around (meaning registered an account and left immediately)?

Check out this article on properly defining Active Users… that should give you a different perspective on the subject. From there, you can figure out how to define a churned customer in your situation.

Great article. I have a business that is exactly 24 months old. The way our website works is that we sign clients up on a 12 month agreement (it has to be 12 months so the client can see the peaks and troughs of the construction industry). The first 15 months of our life our subscriptions were sold at an upfront rate for the 12 months. This was proving to be a hit to the clients cash flow. In the last 9 months we have moved to offering a monthly and quarterly installment package, which was well received by the market. The package is still a 12 month minimum but the option to pay over 12 months (at a slight premium). To calculate our churn i have a few competing factors at play. There is the fact that we have churn for clients not renewing a 12 month subscription. Then we have churn for the clients who are paying monthly but say for example they go broke after 4 payment. Are there any pointers you can provide for working out our correct churn rate. Thank you

This is a perfect example of where cohort analysis is absolutely critical.

You have to look at those within the annual pre-pay plan and those on the post-initial-annual-prepay-month-to-month plan (that’s a mouthful) as different cohorts.

The simple answer is those that are within the annual prepaid plan can’t churn out at a revenue level the only thing they can do is not continue on or renew.

Technically they can become inactive so we could consider that churning out at a customer level if meaningful activity drops below a certain threshold – which would also indicate that they’re not going to renew – but from a revenue standpoint we already have their money up until the one-year anniversary.

As soon as that one year anniversary occurs, if they stop being a customer then we would consider them to have churned out from that annual prepaid cohort.

If they continue on, we would not consider them having churned out of that annual prepay cohort, but would now be in a separate cohort of month to month customers.

And now being a month-to-month customer they have the ability to chur out at any time so we would look at them differently than we would those in the annual prepay cohort.

But the reality is those in the annual prepay cohort could have signed up and prepaid any time between now and 12 months ago and those in the month-to-month plan cohort could have moved on from the annual prepay or quarterly prepaid plans basically at any time since the month-to-month plans offered, so these “cohorts” don’t really mean that much.

From a cohort analysis basis we probably need to slice and dice the data in more meaningful ways; maybe we can look at those that signed up for the annual plan in January or February or March or anybody that’s on the month-to-month plan came from the annual plan or anybody does on the month-to-month plan I came from the quarterly plan or whatever, those are the cohorts we’ll look at.

Also, look at those that “go broke” and churn out as a cohort and look for shared characteristics so you can either help them not go broke (or help you not be affected by that), or so you can avoid acquiring those customers in the first place.

No matter what, there’s probably a more meaningful way to sliced sliced and diced data but hopefully this helps you understand this a little bit better.

The way I look at it is a failed payment doesn’t mean the customer has churned… yet. Though obviously at some point after going through the dunning process and not being able to collect payment, you will have to consider them no longer a customer.

That said, you need to work to ensure your customers are achieving their Desired Outcome and that they consider you so valuable that if their payment fails or a card expires, that they drop everything to make sure you get paid. Cards expire and payments fail… but if you’ve done your job, that won’t result in a customer churning.

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